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If you’re tired of paying for short-term insurance because you think it’s a rip-off, you may be wondering if there is a better option. Self-insuring might save you a lot of money and you’ll be able to invest your savings and get a return. This investment could serve as an emergency fund, but is this a viable solution? Perhaps so, but then you’d have to assume that your car will never be stolen and your house will never burn down.

What is an emergency fund?

Emergency funds can act as a form of self-insurance. The aim would be to make provision for possible future losses, assuming that your fund will be able to cover any disasters that may occur. This would require discipline and depositing premiums into your emergency fund every month.

An emergency fund may work if there are no disasters in the first 10 years and if you avoid using the fund’s money to pay small claims. Assumptions would include that not more than one disaster would occur in a short period, that your house would never be razed to the ground or your car stolen.

How to set up an emergency fund

You could cancel your short-term insurance and deposit the same monthly amount into a savings account. You could also self-insure part of your property but allow for continued short-term insurance on your car and for the possibility of fire.

A mutual fund could be established with family or friends where everybody pays a monthly premium. These joint premiums will increase with compound interest every year. A legal document would have to be drawn up, perhaps with legal assistance.

The advantages of self-insuring

Many people feel that they would rather establish an emergency fund than ‘waste’ their money on insurance, which doesn’t give any return. Premiums are also increased when a claim is submitted and these premiums increase every year, to top it all. Also, although short-term insurance covers all household furniture, it’s normally items like jewellery and electronic equipment that are stolen.

A person may also wish to self-insure simply because they don’t enjoy submitting and dealing with claims.

The disadvantages

The risks of self-insurance are higher than risky shares. It can take a lifetime to replace a house that has burnt down and a decade to replace missing furniture, depending on your financial situation. You may not have peace of mind as a result. Interest earned on the emergency fund is taxable while the value of the fund will be eaten away by inflation.

If your house is destroyed in the first few years of setting up your emergency fund, you may end up being sequestrated but still be responsible for the monthly bond payments. If you’re involved in an accident with an expensive car, you may end up losing more than you bargained for.

The disadvantages of an emergency fund may outnumber the advantages but if you’re prepared to take the risk, perhaps self-insurance is a possibility

Tags: Finances